This series aims to make available to the general public and to economic policy practitioners, a selection of policy papers prepared by the staff of the International Monetary Fund. Papers in the International Economic Policy Review will offer specific policy-relevant analysis, but at a relatively non-technical level. These papers are intended to provide analytical background for IMF-supported programs and more generally to shed light on a range of policy choices facing ministries and central banks.

Introduction

This volume is the first issue of a new series, entitled the International Economic Policy Review, that aims to make available to the general public a selection of policy papers prepared by the staff of the International Monetary Fund. The International Economic Policy Review is aimed at an audience of economic policy practitioners and complements periodicals already published by the Fund: IMF Staff Papers, which includes articles of academic interest, and Finance & Development, which is accessible to a wider noneconomist audience. Papers in the International Economic Policy Review will offer specific policy-relevant analysis, but at a relatively nontechnical level and with only a limited number of supporting tables and charts. These papers are intended to provide analytical background for IMF-supported programs and more generally to shed light on a range of policy choices facing ministries and central banks.

We have selected for this first volume from a series of discussion papers (Papers on Policy Analysis and Assessment) that were issued from their inception in 1992 until the end of 1998, when they were renamed Policy Discussion Papers (PDPs). These papers were selected to be relevant and topical and of general interest beyond a particular country. Updates and revisions from the previous versions have been made as needed. In the future, we intend to issue annual editions of the International Economic Policy Review, each of which will include a selection from the PDPs appearing in the previous year. As mentioned, these papers will be chosen to reflect their general interest and their contribution to one of several topics thought to be especially relevant to the current policy debate.

The papers in this volume are grouped into three general areas: monetary exchange rate policy and the role of the Fund; growth, development, and financial liberalization; and fiscal policy issues.

Part I of the volume, entitled Monetary and Exchange Rate Policy and the Role of the Fund, includes four papers examining several topics intimately related to the IMF’s mandate to oversee developments in the international monetary system. The first paper, by Peter Montiel and Jonathan Ostry, considers a monetary regime that many developing countries have adopted: real exchange rate targeting. While standard analysis suggests that such a regime would lead to nominal indeterminacy—or hyperinflation—this has not occurred in at least some of the countries that have adopted it. The paper shows that real exchange rate rules can easily have destabilizing effects on the inflation rate without resulting in hyperinflation and that such effects are difficult to avoid even when real exchange rate targets are supplemented by an appropriate money-supply rule.

In the second paper, Sharmini Coorey, Mauro Mecagni, and Erik Offerdal discuss the implications for disinflation efforts in transition countries of protracted relative price adjustments—associated, for instance, with ambitious structural reforms. When such relative price adjustments are occurring, an exchange rate anchor is likely to be associated with persistent moderate inflation; bringing inflation down further may thus require a shift to greater exchange-rate flexibility and tighter monetary policy. The paper also notes the risks in this setting of trying to pursue low inflation through tight monetary policy while resisting currency appreciation through sterilized intervention.

The third paper, by Charles Enoch and Anne-Marie Guide, examines another potential mechanism for establishing credibility: a currency board arrangement. Specifically, the paper spells out what needs to be done to make a currency board operational. While the preparations required vary from country to country, they typically involve changing the central bank law, reorganizing the central bank, devising appropriate guidelines for reserve management, and adapting the government’s cash and debt management activities. The paper also discusses the more demanding preparations involved in establishing a currency board in a country with serious banking problems.

Finally, Carlo Cottarelli and Curzio Giannini examine the role the IMF could play in buttressing the credibility of a disinflation program. This may be particularly relevant where domestic mechanisms for building credibility, such as monetary anchors and central bank independence, are vitiated by technical or institutional factors. The paper suggests some possible mechanisms through which the IMF might support programs aimed primarily at disinflation rather than external adjustment.

There are four papers in Part II, on Growth, Development, and Financial Liberalization, a broad area of key and increasing importance for IMF-supported programs and the design of structural reforms in industrial and developing countries alike. The first of these papers, by Tsidi Tsikata, surveys the empirical literature on the effectiveness of aid to developing countries. After noting that aid should stimulate growth by filling financing gaps, the author states that empirical studies have seldom identified an association between aid and growth, seemingly because aid appreciated the real exchange rate and substituted for domestic saving, rather than augmenting it. However, a recent study provides some positive evidence in countries where adjustment efforts were sustained; clearly the nature of supporting policies is crucial for aid effectiveness.

A second paper, by Sanjeev Gupta, Calvin McDonald, Christian Schiller, Marius Verhoeven, Zeljko Bogetic, and Gerd Schwartz, considers ways of mitigating the social costs of the recent economic crisis in East Asia, detailing the measures designed to do so in the IMF-supported programs in effect early in 1998 and suggesting ways in which to improve social safety nets. The programs in Indonesia, Korea, and Thailand all include various measures to shelter the poor from the adverse effects of the economic crisis; these measures include subsidies for staple foods and drugs, public works spending, and extended unemployment and welfare assistance. The authors make suggestions for improving the targeting and sustainability of such measures.

The following two papers consider financial sector issues. The first, by R. Barry Johnston, discusses the proper sequencing of financial liberalization. He points out the links between capital account liberalization and the freeing of domestic financial markets; distortions in the latter may be made more visible when the capital account is opened, making it essential to strengthen domestic regulation and supervision. Aside from this, however, there are no simple answers concerning proper sequencing, and measures should be chosen in light of their contributions to the overall efficiency and stability of the economy. Another aspect of the integration of countries into world capital markets is that countries having assumed external debt may encounter debt-servicing difficulties requiring debt restructuring. Bulgaria is a case in point, and the final paper in Part II, by Aerdt Houben, considers the experience of Bulgaria, which in 1994 reached agreement with foreign creditor banks on restructuring of its debt. This restructuring is generally seen as improving Bulgaria’s prospects for external viability and growth, and the details of the way it was done may provide lessons for other countries in similar circumstances.

The three papers in Part III, on Fiscal Policy Issues, pertain to topics that have also grown in relevance for the IMF’s operational work. The first two papers deal with issues relating to fiscal surpluses, which a number of industrial and developing country governments increasingly have to address—often as they reap the fruits of past fiscal consolidation—and the third paper looks at bank recapitalization in transition economies. The first paper, by Richard Hemming and James Daniel, discusses the appropriateness of targeting a fiscal surplus, and the second, by Nigel Chalk and Richard Hemming, the considerations that guide the choice between alternative uses of a surplus. Noting that a fiscal surplus should not be an end in itself, the first paper identifies two broad situations in which advocating an ex ante surplus might be appropriate: first, when a surplus might be consistent with the government’s pursuit of its traditional allocation, stabilization, and redistribution functions, and second, when governments want to make effective use of transitory capital receipts in the form of foreign grants, resource revenue, and privatization proceeds. Viewing the government as facing separable saving and portfolio decisions, the second paper argues that there may be good economic reasons for either spending or saving a fiscal surplus. In the latter case, it suggests that surpluses that reflect the exploitation of resource wealth are often saved by purchasing assets rather than paying off public debt, but that this might represent an appropriate response also for surpluses related to other circumstances. Both papers summarize country experience with fiscal surpluses.

The final paper in Part III, by Timothy Lane, discusses whether the first-round fiscal and monetary effects associated with a government’s payment of interest on recapitalization bonds are important. It concludes that bank recapitalization may have an important fiscal and monetary impact, but its magnitude and sign depend on the details of the operation and banks’ response to it; it will not in general correspond to the interest paid on recapitalization bonds.

The views expressed in the papers are those of the authors and do not necessarily represent those of the IMF.

Paul Masson

Padma Gotur

Timothy Lane

Editors

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